Why is Rachel Reeves contemplating modifications to the UK’s authorities debt goal? | USAEMALL.com

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UK chancellor Rachel Reeves has opened the door to an overhaul of the way the Treasury handles central bank losses, as she seeks ways of easing pressure on the public finances in her upcoming Budget.

The manoeuvre could give Reeves billions of pounds more fiscal wriggle room for investment, softening some of the “difficult decisions” she has warned she will have to take on October 30 on tax, spending and welfare.

What is the problem?

The Bank of England has bought close to £875bn of bonds to support the British economy since 2009 in response to the global financial crisis and later the Covid-19 pandemic.

The stimulus, known as quantitative easing at first made profits for the central bank, which it transferred to the Treasury, generating £124bn for the public purse by October 2022.

Now the BoE is enduring losses because of higher interest rates. The central bank raised the rate it pays on deposited reserves to a 16-year high of 5.25 per cent last year, and in August made a small cut to 5 per cent.

That is generally higher than the coupon the BoE receives from the bonds it accumulated under the QE programme.

In addition, the central bank has begun selling off the bond portfolio, which is now worth £688bn. In many cases the bank has disposed of bonds for significantly less than what it paid.

Under a 2009 deal with the Treasury, the taxpayer has indemnified the BoE for these losses. An upcoming BoE decision this month on the planned pace of bond sales will have an impact on the costs to the Treasury.

This is unlike countries such as the US, where the Federal Reserve has kept losses from a similar stimulus programme as a “deferred asset” that will be whittled away down the line when the central bank makes profits again.

The Office for Budget Responsibility in March forecast the lifetime net loss on the UK programme at about £104bn.

What could Reeves do about it?

There are several options on the table. One involves the Treasury switching its fiscal target to the UK’s headline measure of public sector net debt.

This gauge accounts for BoE losses earlier than under the measure the Treasury currently targets.

This would ease pressure on the government’s debt target, which requires debt to be falling between the fourth and fifth years of its forecast — currently running to 2028-29. The measure is also affected by the unwinding of the BoE’s term funding scheme for banks.

Using this debt measure would add about £16bn of extra headroom against Reeves’s fiscal rule, compared with the March forecast, according to analysts at the Institute for Fiscal Studies and elsewhere.

Alternatively, the Treasury could design a measure of debt that strips out the impact of BoE losses entirely. City analysts put the benefits of such a move at a similar level.

Investors have signalled they would not be overly concerned by either option, particularly if the change was in aid of boosting investment.

A more radical — and unlikely — move would be to junk the indemnity entirely, so the Treasury no longer forks out for BoE losses. This would take the UK towards the system used by the Fed and US Treasury.

Why has the government not addressed this sooner?

It is only relatively recently that BoE’s crisis programmes started burdening the Treasury, as the central bank raised rates to tame inflation.

While Rishi Sunak’s Conservative government looked at tweaking the debt rule, it was wary of moves that appeared to be an excuse for increasing borrowing, according to people familiar with the discussions.

Jeremy Hunt, the most recent Tory chancellor, softened other aspects of the fiscal rules in 2022 to 2023, but memories of the fiscal fiasco triggered by then prime minister Liz Truss deterred further changes.

The gap between different public debt metrics is set to converge gradually as the decade progresses, lessening the arguments for tampering with them as time goes on.

But having said that she would not tamper with the debt target before the election, Reeves is now looking for any extra Budget capacity she can find.

The extent of the longer-term challenges to the UK public finances was set out by the Office for Budget Responsibility on Thursday, as it warned that public debt was heading on an “unsustainable” path over the coming 50 years.

Asked in August about whether she was planning to adjust the debt target, Reeves declined to rule it out. “We’ll publish the precise details of the fiscal rules in the Budget,” she said.

An HM Treasury spokesperson said: “The chancellor has said her commitment to these [fiscal] rules is non-negotiable and will set out precise details at the Budget.”

The extra headroom gained is ultimately likely to be relatively slender in the context of a government that spends more than £1tn a year, however. To the extent there is a free lunch for the chancellor in all this, it is a modest one.